THE GLOBAL BANKING INDUSTRY IS NOT GOING TO REFORM ITSELF.
NATIONAL GOVERNMENTS ARE RELATIVELY POWERLESS.
INTERNATIONAL ACTION IS NEEDED.
THE EUROPEAN UNION SHOULD LEAD NECESSARY RESTRUCTURING.
The Investment and Banking system is a closed community, deeply resistant to external influence
Markets have many common characteristics. They tend to be very communicative mini-societies, in which the insiders know a lot about what is going on and who is doing what. Any gathering of people, who have broadly similar interests and ways of making a living, will differentiate themselves from other groups of people and develop a set of values that are commonly held amongst them. Financial markets are no different. Historically, many of them were concentrated in particular cities or even particular quarters of particular cities, like Wall Street in New York, or Threadneedle Street in London. These days, electronic communications have made this unnecessary, but the availability of instant data on thousands of screens has if anything tightened the ties that link the players together.
International linkages are strengthened by the development of huge global investment banks, organizations employing hundreds of thousands of people who, at senior levels, are likely to hold common values and beliefs regardless of their nationality, whose training and skills have common roots, and who share similar goals.
So, what are the factors that indicate that the financial markets really do constitute closed working communities?
Such a list might well start with rewards. Research indicates that people who receive very high rewards for a particular activity come to believe that the things they do are very important and valuable. The availability of high rewards for particular forms of behaviour will tend to perpetuate and make it difficult to question them. For example, the total of bonuses paid in 2005 to some 300,000 people who work in the City of London is reported to have been in the region of £19 billion and this level of rewards has not in any way diminished since the baking crisis. Many traders, analysts and particularly investment bankers earn multi-million sums in an average year and multiples of this in boom times.
Reward in the financial markets is internally determined. Despite current proposals, there is no reference to outside bodies that might be able to have a moderating influence, or feed in challenging perspectives. Therefore, several things seem to have happened.
Firstly a lot of people, whose roles and skills strike external observers as no more special than the majority of professionally demanding jobs, seem to be hugely rewarded.
Ah, say some, but what about the value created by good operators in the financial markets. Surely market forces will determine rewards? Well, once again, there is evidence of self-determining system at work. Take investment bankers' fees for instance......
Rule 3 of The City of London Code on Takeovers and Mergers stipulates that, in the event of a takeover bid, the "Board of the offeree must obtain independent competent advice on any offer and the substance of such advice must be made known to its shareholders". Important shareholder protection no doubt, but most of the "shareholders" are in fact investment institutions which are part of the same system, so it would seem logical to them to ensure that other members of the 'market' (even the same investment bank) get a guaranteed crack at the huge fees incurred in deals.
Martin Dixon, in the Financial Times of 6 January 2004 wrote; "....the sums involved (in investment banker's fees) border on the obscene. For example, Blue Circle in 2003 spent some £27 million on advisers - roughly 10% of annual pre-tax profits, a not untypical figure - as it successfully defended itself against Lafarge. (Not very long after, Lafarge and Blue Circle, again with expensive help from both their advisers reached agreement on the takeover and Blue Circle passed into French ownership.) Nor are fees obviously related to an adviser's input to a bid......so how can bankers get away with it? Two reasons - their oligopolistic powers and their clients' fear".
To summarise the situation, the players in the financial markets reward themselves very richly by comparison with other professional workers and raise the money to do this, at least in part, by extracting huge fees from clients and customers, some of whom are convinced that their tenure and wealth is dependent on the goodwill of investment banks. So, why do corporate managers not simply refuse to pay so much in fees? Many managers believe (rightly) that they need the goodwill of the markets to be employable in a senior job. In other words, they have been, willingly or otherwise, "recruited" into the system.
Closed systems are often cut off from the outside by shared systems of belief and patterns of expression and thought that excludes anything uncomfortable, a symptom of 'Groupthink'. Bodies of people become capable of persisting with patterns of thought and action that are damaging or irrational, despite strong external evidence. Also, groups of people may develop forms of expression amounting to a local form of political correctness that may deny or twist the truth because it is uncomfortable.
Is there evidence of such syndromes in the financial markets? Certainly.
Probable manifestations are the strong tendency towards herd-like behaviour and espousing of fads and crazes. In the short term, rumours can cause quite violent swings in share prices, even if they often seem far-fetched to outsiders. Some rumours are almost certainly started deliberately and some are simply the product of a rather nervous herd mentality. We must all have seen a flock of sheep suddenly seized by a momentary panic!
To quote George Soros in The Crisis of Global Capitalism, "The belief in fundamentals is eroding and trend-following behaviour is on the rise. It is fostered by the increasing influence of institutional investors whose performance is measured by relative rather than absolute performance and by the large money center banks that act as market makers in currencies and derivatives. They benefit from increased volatility both as market makers and as providers of hedging mechanisms."
There is a strong tendency for market behaviour to exaggerate the natural cyclical ups and downs of economic growth. In bull markets, over-optimism rules and both markets and companies behave as though boom conditions will last forever. Companies indulge in deals and transactions that will need to be undone the moment the market steadies.
Overpayment for acquisitions becomes rife. Value is destroyed by foolish and risky strategies. Greed becomes rampant, great pressure is exerted by investment banks to exploit the good times through excessive growth, and weird theories heralding the end of cyclical downturns are fervently believed.
The closed culture of investment banking caused the crisis
It was the closed nature of the global banking system and its rejection of any serious intrusion from governments or regulators that led to the crisis of 2008 - ? Banks developed a reliance on all manner of complex investment and hedging instruments to the point that a huge system of incalculable risk was set up. Insiders from this time have reported the total unacceptability of questioning the accepted beliefs. This system generated enormous wealth for banking insiders and has impoverished hundreds of millions, some to the point of starvation.
And will fiercely resist reform
It is the same closed system that is fighting a fierce action, using all means available, to resist any serious changes in global banking. The banks use intimidation, immediate or deferred inducements and a massive publicity machine to influence politicians and the public into believing that the value of what they do is so great that whole economies will collapse if they are interfered with in any serious way. This behaviour is to be seen at its most strident in London, where it has been put about that any serious modifications to or restrictions on banking practice (including bonuses) will lead to a flight of the industry from the UK. The other side of the picture - the immense damage done to the UK economy by its dependence on finance and the near death of science, technology and manufacturing industries caused by investment starvation; and the misery to millions of lives from debt and rampant consumerism driven by irresponsible lending - is seldom mentioned.
Politicians in the UK and US are unlikely to lead reform
Faced with this intimidation UK politicians have taken a cravenly timid line. (We still await decisive action from the Obama administration). The late conversion by the New Labour government to the view that the banking industry needs serious reform is evident only in their rhetoric rather than their actions. Government still seems to have a naïve belief that appointing banking insiders to propose reform and encouraging self-regulation will somehow bring about change. The recent review conducted by Sir David Walker, a banking insider, was typical of the half-hearted wish-lists and recommendations to be expected from the financial establishment.
The actions needed are almost "no-brainers".
First. Investment banking needs to be separated from the retail side of the industry. Retail banking is a relatively simple activity, essentially that of receiving peoples' investments and savings; investing sensibly and transparently to give reasonable returns and lending money to individuals and smaller businesses. It is an activity that should be subject to strong influence from customers to ensure fair and reasonable treatment and is very suitable for mutual or co-operative forms of organization and ownership.
Second. Investment banking as a separate activity should be strictly regulated so that the greedy, speculative tendencies deeply embedded in the banking culture can be controlled. Taxation on speculative transactions is a way to proceed. It is hopeless to expect bankers to reform themselves, the cultural habits of the industry are so deep that only externally imposed sanctions will work.
Third. The tax havens that have been used by financial speculators, tax avoiders and money-laundering criminals to shelter their activities must be opened up to scrutiny by an international independent body.
By now two things should be perfectly clear:
- No matter how strong the case for doing it, the UK government is not going to act decisively to re-structure the banking industry in order to cause it to be responsive to the needs of society
- The industry is not going to volunteer significant change.
Action should therefore be led by international bodies such as the European Union and through EU influence, the IMF. The EU is a strong economic and increasingly coherent political influence not dominated by governments, like Britain's, that ever bought into market fundamentalism. The influence of Germany, France, the Netherlands and some of the Scandinavian countries mean that British resistance to reform can be overcome. The EU also has considerable influence over the IMF and is strong enough to stand up to pressures from the banks.